INSOLVENCY & BANKRUPTCY ISSUES FOR INFORMATION TECHNOLOGY · PDF fileInsolvency & Bankruptcy...

INSOLVENCY & BANKRUPTCY ISSUES FOR

INFORMATION TECHNOLOGY

Michael A. Fitch, Q.C. Fasken Martineau DuMoulin LLP

Suite 2100, 1075 West Georgia Street Vancouver, B.C. V6E 3G2

April 2002

.

* The author acknowledges with appreciation the contribution to this article by Patrick Shea of Gowling LaFleur

Henderson LLP, Toronto, who prepared an earlier version for this year’s Toronto Conference of IT CAN.

© International Insolvency Institute – www.iiiglobal.org

INSOLVENCY & BANKRUPTCY ISSUES FOR INFORMATION TECHNOLOGY

I. Introduction

This paper attempts to provide a modest overview of the Canadian insolvency regime

with an emphasis on the issues that can arise in a liquidation or reorganization of an

information technology business. Not surprisingly, insolvency laws do not treat

insolvent information technology companies any differently than any other insolvent

companies. Accordingly, the fact that the property of information technology companies

consists, to a large extent, of information, contracts and intangible property presents

unique challenges in an insolvency because the current legislation (and relevant

jurisprudence) does not have extensive experience dealing with these types of assets.

This paper looks at the issues that most often arise in an insolvency where the debtor’s

assets consist primarily of information, contracts, and intangible property.

Unfortunately, the reader will find problems throughout the paper, but very few solutions

either in the legislation or the case law. The reason for this is, simply put, that our

insolvency laws were developed in an era of “bricks and mortar” businesses.

Consequently, they are not designed to deal with the realities of technology-based

businesses where, more often than not, the insolvent company’s assets consist primarily

of intellectual and intangible property rather than buildings and equipment.

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Insolvency & Bankruptcy Issues for Information Technology

II. The Framework

The Canadian insolvency regime is centred around two pieces of federal legislation: the

Bankruptcy and Insolvency Act1 and the Companies’ Creditors Arrangement Act2. The

BIA is a comprehensive statute that provides for both the liquidation, through

bankruptcy, and the reorganization of insolvent debtors. Unfortunately, the statute dates

from the late 1940’s and, while it has been amended on a number of occasions, it still has

major gaps in how it deals with contracts and intangible property in the context of both

liquidations and reorganizations.

The CCAA stands in stark contrast to the BIA. Originally enacted in the 1930’s, it

provides only for the reorganization of larger, more complex insolvent businesses.

Rather than providing detailed substantive and procedural provisions to govern all

aspects of the reorganization like the BIA, the CCAA provides a general framework and

then leaves it to the debtor to work out the details of the process under court supervision.

Much of the law under the CCAA developed by way of judicial interpretation.

In addition to the liquidation and restructuring regimes of the BIA and the CCAA, this

paper deals briefly with court-appointed receivers and interim receivers. Both are

appointed by the court in insolvencies and play an important role in liquidations and

reorganizations where they are used to effect asset sales.

The aim of liquidation is to maximize the value of the insolvent company’s assets. This

generally involves selling the insolvent company’s assets to the party or parties willing to

pay the highest price. In the case of an information technology business, this can involve

selling intellectual property free and clear of contractual rights, such as licenses, or

selling hard assets, such as computers, together with contractual rights such as licenses.

The aim of restructuring, on the other hand, is to preserve the going concern value of a

business. Although restructuring may involve selling assets, it will usually also involve

terminating or disclaiming unprofitable contracts, renegotiating contracts (often under 1 R.S.C. 1985, c. B-3, as amended (the “BIA”). 2 R.S.C. 1985, c. C-36, as amended (the “CCAA”).

© International Insolvency Institute – www.iiiglobal.org Page 2


threat of termination), closing down divisions, terminating employees, etc. The objective

is to “fix” the business that existed prior to the commencement of the formal insolvency

procedure, thereby creating a new business that can viably go forward for the benefit of

stakeholders.

It is important to note that while this paper makes a clear distinction between the

liquidation of insolvent companies, on the one hand, and their reorganization on the

other, in modern insolvency practice the line between a “reorganization” and a

“liquidation” is often blurred. Many liquidations involve the sale of all the assets of an

insolvent company to a new company which continues to carry on the insolvent

company’s business and many attempted reorganizations ultimately result in the orderly

liquidation of the insolvent company’s assets.

III. Bankruptcy Liquidations

In the context of a bankruptcy, the BIA is intended to deal primarily with the bankrupt’s

unsecured creditors. The right to file a claim and receive a dividend in the distribution of

the proceeds derived from the liquidation of the bankrupt’s unencumbered assets replaces

all of the pre-bankruptcy remedies available to unsecured creditors. The bankrupt’s

secured creditors, on the other hand, have the ability to enforce their security outside of

the bankruptcy, generally through the appointment of a receiver. While there is some

limited ability to bring secured creditors into the bankruptcy process, secured creditors

normally proceed to enforce their security without regard to the bankruptcy and turn

whatever excess proceeds may exist, once their secured claims have been satisfied, over

to the trustee to be distributed among unsecured creditors in the bankruptcy.



1. Initiation of the Bankruptcy

An insolvent debtor can initiate a bankruptcy itself by filing an Assignment for the

general benefit of its creditors with the official receiver3 (the official appointed by the

federal government to oversee the administration of bankruptcies and reorganizations

taking place under the BIA.) The Assignment itself is a standard-form document

pursuant to which the debtor assigns all of its property to a bankruptcy trustee to be

administered as required by the BIA. Unsecured creditors can also force an insolvent

debtor into bankruptcy by applying to the court by way of Petition4 seeking an order

declaring that the debtor is bankrupt and appointing a trustee over its property. Finally, a

bankruptcy automatically results if an attempt by an insolvent debtor to reorganize under

the BIA is unsuccessful5.

2. Stay of Proceedings

Once a bankruptcy has commenced, the rights of unsecured creditors to pursue their

claims against the bankrupt or its property are stayed6. Unsecured creditors can apply to

the court for relief from the stay to pursue their remedies against the bankrupt and/or its

assets. However, to be successful, the unsecured creditor must establish that it is being

prejudiced by the stay or that other equitable grounds exist that warrant the leave. As a

general rule, it is extremely difficult for an unsecured creditor to obtain leave from the

stay in order to pursue an action or to take steps to enforce its claim.

However, the bankruptcy stay does not generally impact secured creditors7. The BIA

permits the court to temporarily suspend a secured creditor’s right to enforce its security

and restricts the ability of a secured creditor to realize its security in circumstances where

3 BIA s. 49. 4 BIA s. 43. 5 BIA s. 50.4(8) (failure to file cash flow or proposal), s. 57 (creditors do not accept the proposal), s.

61(2) (court refuses to approve proposal) and s. 63(4) (annulment of proposal as a result of default). 6 BIA s. 69.3(1). 7 BIA s. 69.3(2).



the collateral is held by the secured creditor and the bankruptcy trustee wishes to inspect

the collateral. However, in actual practice, this rarely happens8.

3. Administration of the Bankruptcy

Whether a debtor files an Assignment, the debtor is declared bankrupt on the Petition of a

creditor or the debtor becomes bankrupt as a result of a failed reorganization, the

bankruptcy has the effect of vesting all of the debtor’s unencumbered property in the

bankruptcy trustee. The property that vests in the trustee includes not only tangible

property but also choses in action, rights under contracts, etc.

While rarely used, the trustee has the power to continue the bankrupt’s business “for the

beneficial administration of the estate”9. As a practical matter it is extremely rare for a

bankruptcy trustee to continue the bankrupt’s business. If the intention is to carry on the

business of the insolvent debtor, it is generally the case that the secured creditor will

either appoint a receiver privately or seek a court order appointing a receiver to do so. If

a bankruptcy trustee does carry on the bankrupt’s business the trustee is generally

personally liable for goods and services purchased or contracts entered into while

carrying on the business.

4. Recovery of Property

The trustee is only vested in property beneficially owned by the bankrupt. If the bankrupt

is in possession of property owned by another party, ie. intellectual property or customer

information, the BIA provides for the recovery of that property. The BIA requires that a

person asserting an ownership interest in property file a Proof of Claim (Property)

asserting the proprietary interest in the specified property.10 The claimant bears the

burden of establishing that it owns the property.

8 See BIA s. 69(2)(a) and (b) and s. 79. 9 BIA s. 30(1). 10 BIA s.81



5. Impact of Bankruptcy on Contracts

Intellectual property is typically the subject of contractual arrangements between

companies, usually in the form of license agreements. Where the party owning or

creating the intellectual property becomes bankrupt, third parties holding licenses from

the bankrupt will be concerned to preserve their licensing rights, notwithstanding the

bankruptcy. Conversely, where the licensee becomes bankrupt, the solvent licensor will

generally wish to terminate the contract to enable it to take back the rights contained in

the license agreement and dispose of them to a different party in the public marketplace,

rather than having the trustee maintain the benefits under the license and dispose of them

independently without the licensor’s consent. Unfortunately, the BIA is not clear on how

contracts, including these types of licence agreements, are impacted by the bankruptcy of

one of the parties to the contract.

a. Retention of Contracts by a Trustee

A bankruptcy does not, in and of itself, automatically terminate a contract or constitute a

breach of that contract except in the case of contracts which are personal in nature, such

as employment contracts. If it so chooses, therefore, a bankruptcy trustee is generally

entitled to perform a contract and to require the other party to perform it. However, if the

trustee does not perform under a contract within a reasonable period of time, the other

party to the contract can treat the contract as broken11.

In an attempt to prevent a bankruptcy trustee from enforcing a contract after bankruptcy,

agreements will often provide for an automatic termination of the agreement on

bankruptcy, or will provide for bankruptcy to constitute an event of default. The BIA

contains no legislative provisions specifically staying the enforcement of such automatic

termination or default clauses in the case of a bankruptcy. However, most insolvency

practitioners are of the view that such clauses are not enforceable against a bankruptcy

11 L.W. Houlden and G.B. Morawetz, The 2002 Annotated Bankruptcy and Insolvency Act (Carswell) at

Fδ45.2.



trustee. In Canadian Imperial Bank of Commerce v. Bramalea Inc.12 the court dealt with

the enforceability of a clause in a partnership agreement triggered by insolvency or

bankruptcy alone, which purported to allow a solvent partner to purchase the insolvent

partner’s interest for less than its fair market value. Blair J. found that such a contractual

provision is not enforceable and is void on the basis that it violates public policy where it

has the effect of depriving the creditors of value.

It is, therefore, likely that other events of default will have to be relied upon by a licensor

when attempting to terminate a license agreement where a bankruptcy trustee for the

licensee attempts to retain the license.

b. Disclaimer of Contracts by a Trustee

The opposite situation arises in circumstances where the bankrupt has by contract granted

rights in its property to a third party, and the third party wishes to prevent the bankruptcy

trustee from disclaiming that contract. Although the BIA contains no provision that

directly permits the trustee to disclaim commercial contracts, the English case law

appears to suggest that a bankruptcy trustee may disclaim a commercial contract13, and in

practice trustees routinely do so.

However, one reported case that suggests that if a bankruptcy trustee has the right to

disclaim commercial contracts, it cannot disclaim a contract that has the effect of

transferring property. In Re Erin Features No. 1 Ltd., the British Columbia Supreme

Court decided that a bankruptcy trustee could not disclaim a contract granting exclusive

marketing rights to a film because the contract was actually a transfer of property14.

Prior to its bankruptcy, the bankrupt had negotiated an agreement that granted exclusive

marketing rights in Canada to Modern Cinema Marketing Ltd. for a film entitled

Lighthouse. After the bankruptcy, the trustee sought to terminate this agreement.

12 44 B.L.R. (2d) 188 (Ontario Court of Justice). 13 See L. Duncan and J.D. Honsberger Bankruptcy in Canada (3d) (Canada Law Book, 1961) at 136 and

333. See, however, M.J. Forte and A.C. Chester “Licenses and the Effect of Bankruptcy and Insolvency Law on the Licensee” included in the materials for the Turnaround Management Association’s Third Annual Symposium (February 1, 2001).

14 Re Erin Features No. 1 Ltd. (1991), 8 C.B.R. (3d) 205 (B.C.S.C.).



However, the court characterized the arrangement as a sale by Erin of property, namely

the exclusive right to market the film. As a result the contract could not be disclaimed by

the trustee15.

It should be noted that it is generally accepted by information technology and intellectual

property practitioners that a transfer of a license does not constitute a transfer of property.

Specifically, a license has been described as nothing more than permission from the

licensor to the licensee to make use of its intellectual property16. As a result, it seems to

be possible for a bankruptcy trustee to disclaim a license, leaving the affected licensee

with nothing more than an unsecured claim in the bankruptcy for damages resulting from

the termination.

6. Assignment of Contracts by Trustee

The issue of disclaimer is probably more theoretical than real in the context of most

license agreements since the primary role of a bankruptcy trustee is to maximize the

value of the estate for creditors. Assuming that the license grant provides a continued

income stream to the bankrupt into the future, the trustee is not likely to disclaim

contracts but rather to attempt to preserve them as part of the bankrupt’s unencumbered

property that the trustee will attempt to assign as part of the asset sale to increase the

proceeds available for distribution to creditors. In the context of a bankruptcy involving

intellectual property or intellectual technology assets, the issue is likely to be whether the

purchaser acquires property, such as technology, subject to, or free of, rights, such as

licenses, that were granted in that property by the bankrupt. In that context, the key issue

is whether or not the trustee can assign contracts to a purchaser, such as software

licenses, without the consent of the other party to the license agreement.

The BIA is silent with respect to a bankruptcy trustee’s general ability to assign a

contract, but there is nothing to suggest that the ordinary common law with respect to the 15 Re Erin Films has been criticized -- see G.G.S. Takach and E.L. Hayes “Case Comment” 15 C.B.R.(3d)

66. However, the criticism has related to whether property was conveyed and not with the concept that a pre-bankruptcy contract that has the effect of conveying property cannot be disclaimed. An exception would be if the conveyance was a settlement or preference.

16 W.A. Adams and G.G.S. Takach “Insecure Transactions” 33 C.B.L.J. 321 at 350.



assignment of contracts would not apply to such an assignment by a bankruptcy trustee.

However, Bramalea suggests that contractual clauses that restrict assignment in an

insolvency are not enforceable.

The general common law test with respect to the reasonableness of a refusal to consent to

an assignment has two parts17:

(a) first, the court must determine the basis for the refusal to consent; and

(b) having determined the basis for the refusal to consent to the assignment, the

court will then determine whether that basis is reasonable.

In determining whether consent is unreasonably withheld the court will also consider the

following:

(a) the covenant in the agreement and its purpose in that context;

(b) all of the circumstance of the case including the commercial realities of the

market place and the economic impact of the assignment on the non-

assigning party;

(c) the non-assigning party is not entitled to refuse his consent so as to be able to

acquire a further commercial benefit for himself by insisting on conditions

which were outside of the original agreement and thus obtain more

advantageous terms; and

(d) it is unreasonable for the non-assigning party by withholding his consent and

insisting on different terms and conditions, to rewrite ex post facto the

assignment covenant which it and the parties had previously freely

negotiated.18

17 Lehndorff Canadian Pension Properties Ltd. v. Davis Management Ltd., [1987] B.C.J. No. 1228 (Sup.

Ct.), aff’d [1989] B.C.J. No. 990 (C.A.) at para 51. See also Welch Foods Inc. v. Cadbury Beverages Canada Inc. [1999] O.J. No 544 (Gen. Div.), aff’d [2001] O.J.

18 Jo-Emma Restaurants Ltd. v. A. Merkur and Sons Ltd. [1989] O.J. No. 1803, 7 R.P.R. (2d) 298 (Dist. Ct.) at p. 3



It is important to point out that the failure to respond to a request to assign a contract can,

in and of itself, be considered unreasonable.19 For example, the Alberta Court of Queen’s

Bench has found that: “[…] Notice of Termination is not an answer to the request for

consent. The [Landlord] is obliged to state reasons for withholding its consent” and “[…]

failure by [Landlord] to answer the request for its consent, except to issue a Notice of

Termination…, without more and without further explanation, provides no reasons for

withholding consent. Obviously that is tantamount to an unreasonable withholding of its

consent.”20

There are no bankruptcy cases on this issue. The application of these cases in an

insolvency has, however, been considered in the context of a CCAA restructuring and is

discussed later.

7. Property Rights on Asset Sales by Trustee

Where transfers of assets occur in a bankrupt estate, the BIA provides that sales of

property by the bankruptcy trustee vest in the purchaser all of the legal and equitable

estate of the bankrupt in that property21. Acquisitions from a bankruptcy trustee will,

therefore, be subject to certain interests in the bankrupt’s property held by third parties22.

These would include, for example, proprietary interests that may exist in favour of third

parties, since the bankruptcy is not able to impact those property rights. This issue was

recently considered by the Alberta Court of Appeal in Bank of Montreal v. Dynex

Petroleum Ltd.23 The issue in Dynex was whether the sale of oil and gas properties by a

bankruptcy trustee would be subject to overriding royalty interests (an unencumbered

share or fractional interest in the gross production from an oil and gas property) granted 19 Cornish v. Boles (1914), 31 O.L.R. 505 (C.A.). St. Jane Plaza Ltd. v. Sunco Inc., [1992] O.J. No. 1339

(Gen. Div.) at p. 4. 20 Zurich Canadian Holdings Ltd. v. Questar Exploration Inc. [1998] A.J. No. 609 (Alta Q.B.) at paras 64

and 66. 21 BIA s. 84. 22 It should be noted that courts have, for practical reasons, made orders in the context of a bankruptcy

vesting assets in a purchaser free and clear of the claims of secured creditors and statutory deemed trusts. These types of orders are typically made in situations where the amount owing by the bankrupt in respect of unremitted source deductions is in excess of the purchase price being paid for the assets.

23 182 D.L.R. (4th) 640 (Alberta Court of Appeal).



by Dynex. Specifically, the question was whether an overriding royalty interest could be

an interest in land, as opposed to a chose in action that gave rise to an secured or

unsecured claim in the bankruptcy. A decision that was upheld by the Supreme Court of

Canada analysed the function of royalty interests and the way they were treated in the oil

and gas industry as a matter of practice. The court determined, in a departure from the

traditional common law view, that overriding royalty interests could be interests in land.

As a result, the purchaser in this case acquired the properties subject to the royalty

interests.

8. Sale of Patented and Copyrighted Property

While the BIA contains no provisions respecting trade-marks, industrial designs or plant

breeder’s rights, it does deal with the sale by a bankruptcy trustee of patented articles and

copyrighted materials.

Section 82 of the BIA deals with the sale of patented articles. Pursuant to this section, a

bankruptcy trustee can sell patented articles that were sold to the bankrupt subject to

restrictions or limitations free and clear of those restrictions or limitations24. However,

the act balances the rights of the manufacturer or vendor of patent articles and the trustee

by giving them the right to purchase the articles from the trustee25.

Section 83 of the BIA makes provision for how a bankruptcy trustee may deal with

copyrighted materials or interests in copyrights assigned to the bankrupt. Subsection

83(1) deals with situations where the copyrighted work has not been published and put on

the market prior to the bankruptcy, and subsection 83(2) deals with the situation where

the copyrighted work has been published and put on the market.

According to subsection 83(1), if no expenses have been incurred in connection with the

copyrighted work, then the work must be returned to the author and any agreement

between the author and the bankrupt automatically terminates and becomes void. If, on

the other hand, expenses have been incurred by the bankrupt in connection with the 24 BIA s. 82(1). 25 BIA s. 82(2).



copyrighted work, the author may pay those expenses to secure the return of materials

and the termination of the contract. If the author does not wish to pay the expenses

incurred by the bankrupt, the trustee has six months to carry out the contract between the

bankrupt and the author before the agreement terminates and becomes void.

If the copyrighted works were published and put on the market at the time of the

bankruptcy, the bankruptcy trustee may sell copies of the published work subject to

certain restrictions26. The trustee must pay any royalties or share of profits to which the

author would be entitled and before selling copies of the copyrighted materials, the

bankruptcy trustee must offer to sell all of the copies to the author27. Once all of the

copies of the published work have been sold, the contract between the bankrupt and the

author terminates and becomes void.

The trustee may not assign or license the copyrighted materials except on terms that

guarantee that the author will receive any royalties or share of profits to which the author

would be entitled. However, if appropriate guarantees are provided, the consent of the

author to an assignment by the trustee is not required28 and it appears that the trustee can

assign notwithstanding any terms in the agreement that restrict the assignment of

copyrighted materials.

IV. Reorganizations

As mentioned above, there are two separate reorganization regimes in Canada -- BIA

reorganizations (known as “proposals”) and CCAA reorganizations. BIA proposals are

generally used in smaller insolvencies and the regime is fairly rigid due to the fact that

the BIA provides a complete code for the restructuring. There is very little room for

creativity in the BIA proposal process.

26 BIA s. 83(2). 27 BIA s. 83(3). 28 Re Song Corp. (January 7, 2002) File No. 31-388643 (Ont. S.C.J.)



1. BIA Proposals

a. Initiation of BIA Reorganizations

Under the BIA, reorganizations are most commonly initiated by filing a standard-form

document called a Notice of Intention to Make a Proposal naming a bankruptcy trustee

who has consented to supervise the debtor while it attempts to develop a reorganization

plan, known as a proposal.

In a BIA proposal the insolvent debtor generally remains in possession of its assets and

continues to manage its business and affairs. The function of the trustee is to monitor the

debtor’s financial situation and report any material adverse changes to the court. The

trustee does not interfere in the operation of the debtor’s business. If there is a need for

greater supervision, the court has the jurisdiction to appoint an interim receiver to provide

more active monitoring or to take control of the debtor’s assets and business operations.

For a proposal to be accepted, a majority of the creditors in each class of unsecured

creditors must vote in favour of it, while holding two thirds in value of the total debt

represented by that class. Secured creditors do not directly influence the approval of the

proposal by the unsecured creditors, but if a class of secured creditors does not

independently approve of the proposal they are no longer bound by the stay and are free

to deal with their collateral as they wish. Rejection by a class of secured creditors can,

therefore, seriously jeopardize the possibility that the debtor will be able to continue as a

going concern and, as a practical matter, rejection by secured creditors will often spell the

end of a reorganization. Once a proposal has been accepted by the creditors, it must be

approved by the court before it becomes binding.

As discussed above, the failure of a proposal results in the automatic bankruptcy of the

insolvent debtor. If, for example, the creditors do not vote to accept the debtor’s proposal

or the court refuses to approve of the proposal, the debtor is deemed to have made a

voluntary assignment in bankruptcy.



b. Stay of Proceedings

Once the debtor files a Notice of Intention, an automatic thirty day statutory stay of

proceeding arises that prohibits the creditors, both secured and unsecured, from

exercising any remedy against the debtor or its property, or from commencing or

continuing any action, execution or other proceeding for the recovery of a claim provable

in bankruptcy29. This stay, and the time for filing a proposal, can be extended by the

court in forty-five day blocks for a maximum period of six months30.

A secured or unsecured creditor may apply for relief from the stay when it can satisfy the

court that:

(a) the creditor will be materially prejudiced by the continued operation of

the stay; or

(b) it is equitable on other grounds to grant that creditor relief from the stay.

The burden of proof in an application for relief from a stay in a BIA reorganization falls

on the creditor and it is generally seen as a difficult burden to meet. A creditor seeking

relief from the stay must establish that its indebtedness or, in the case of a secured

creditor, its security, is at risk or that there has been some improper conduct on the part of

the debtor. As a general rule, unsecured creditors will rarely be able to obtain leave to

pursue actions against a reorganizing debtor.

A creditor may, at any time, apply to the court asking that the reorganization process be

terminated if it can satisfy the court that:

(a) the debtor has not acted or is not acting in good faith and due diligence;

(b) the debtor in not likely to be able to make a viable proposal; or

(b) the creditors as a whole would be materially prejudiced if the proposal

process was not terminated.

29 BIA s. 69.1. 30 BIA s. 50.4(9).



c. Doing Business With the Reorganizing Debtor

The BIA prohibits parties to existing contracts with the reorganizing debtor from

terminating contracts or discontinuing service on the basis only that the debtor is

insolvent, has commenced a reorganization or, in the case of leases, licenses and utilities,

has failed to make a payment due prior to the commencement of the reorganization31. It

is impossible to contract out of these provisions, but the court may declare that they do

not apply if the other party to the contract satisfies the court that the operation of the

provisions would likely cause “significant financial hardship.”32 There are no reported

cases dealing with what constitutes a significant financial hardship.

It is important to note that parties who are prevented from terminating contracts are not

restricted from terminating on the basis of non-insolvency defaults and are not required to

extend further credit to the debtor. Moreover, they can demand immediate payment for

goods and services delivered or supplied after the commencement of the reorganization33.

In Re Cosgrove-Moore Bindery Services Ltd.34 the Court considered s. 65.1(4) of the

BIA, the provision which permits suppliers to require immediate payment for goods and

services supplied, and the use of leased property subsequent to the filing of a Notice of

Intention. In that case the company’s landlord and an equipment lessor made motions

seeking orders requiring that the debtor make immediate payment for use of the leased

property. The court found that the purpose of s. 65.1 was “to provide a commercial

enterprise with the opportunity to continue operations while working toward a

reorganization while at the same time to give creditors obligated to continue to supply

goods, services or the use of leased property some protection that payments ordinarily

due during the proposal period will not be wiped out or reduced to pro rata unsecured

claims in the event of an ultimate bankruptcy.” The court also found that suppliers were

not required to commence actions to recover amounts owing and ordered that the debtor

make immediate payment under the leases going forward.

31 BIA s. 65.1(1), (2) and (3). 32 BIA s. 65.1(5) and (6) 33 BIA s. 65.1(4). 34 (2000), 17 C.B.R. (4th) 205 (Ont. S.C.J.).



Unfortunately if a reorganization is not successful, suppliers who have not been paid for

goods or services supplied during the reorganization are unlikely to receive payment. As

mentioned above, in the case of a BIA reorganization if the reorganization fails the debtor

is deemed to have made a bankruptcy assignment as of the date of the event that triggers

the failure. The BIA does not contain any provisions that protect creditors who supplied

to the debtor in the period between the commencement of the reorganization and the

deemed assignment. In the BIA distribution scheme such creditors will be treated as

ordinary unsecured creditors.

The decision in Pike v. Bel-Tronics Co.35 provides an unfortunate example of the risk of

supplying goods and services to a reorganizing debtor. Bel-Tonics Co. filed a Notice of

Intention. The proposal was rejected by the company’s creditors and as a result, the

company was deemed to have made a bankruptcy assignment. Bel-Tronics owed its

suppliers a substantial sum of money for goods supplied subsequent to the filing of the

Notice of Intention. The bankruptcy trustee, supported by one unpaid supplier, made a

motion seeking an order requiring that the receiver appointed by the secured creditor pay

amounts owing to these suppliers. The court ultimately found that the unpaid suppliers

would be unsecured creditors in this bankruptcy.

There are a number of business solutions that can be used to protect suppliers from the

risk that the debtor’s reorganization may fail. For example, suppliers may insist on

payment in advance or payment on delivery, or may insist that the company provide a

standby letter of credit. Sometimes suppliers can make arrangements with the debtor for

payment to be made via wire transfer in advance of fulfilling the company’s orders. The

ability of a supplier to negotiate these sorts of arrangements will depend on a number of

factors including the importance of the supplier’s goods and services to the debtor’s

ability to carry on business, and whether the suppler is party to a pre-existing supply

contract with the debtor (parties to contracts with a reorganizing debtor are generally

stayed from terminating or amending such contracts.)

35 (2000), 19 C.B.R. (4th) 262 (On. S.C.J.).



d. Disclaimer of Contracts

With one exception, the BIA is silent with respect to the ability of a reorganizing debtor

to disclaim contracts. The BIA permits a reorganizing debtor to disclaim real property

leases and to make provision for any damages caused by the disclaimer in its proposal36.

In the event that a reorganizing debtor were to terminate a contract after filing a Notice of

Intention, any damages suffered by the other party to the contract would most likely not

be subject to the proposal. Rather, they would not be compromised and the debtor would

remain liable for the damages notwithstanding its reorganization. This is because in a

BIA reorganization (unlike the CCAA) claims are determined as at the date of the filing

of the Notice of Intention37. Arguably, any claim arising from a termination after that

date would not be subject to the proposal. This is one of the primary reasons why most

large corporations will seek to reorganize under the CCAA rather than the BIA, since the

termination of unprofitable contracts is often a major component of a typical restructuring

strategy.

e. Selling Assets/Assigning Contracts

The BIA, not surprisingly, does not deal with the sale of assets or assignment of contracts

by a reorganizing debtor. That being said, it is clearly possible for a reorganizing debtor

to sell assets or assign contracts and seek an order vesting those assets and/or contracts in

a purchaser free and clear, during the restructuring process. In this type of transaction,

the same issues will exist with respect to the ability of the court to vest assets free and

clear of interests arising under contract as will be discussed below in the context of

CCAA reorganizations.

2. CCAA Reorganizations

Rather than provide detailed substantive and procedural provisions to govern all aspects

of the reorganization, the CCAA provides only a general framework for the 36 BIA s. 65.2 37 BIA s. 62(1.1). If a proposal is filed, as apposed to a Notice of Intention, the date for determining claims

is the date of the proposal.



reorganization of a insolvent business. The details of the reorganization process are

established by the court through orders made during the restructuring process. The result

is a flexible regime that can be adapted to suit the specific needs of the insolvent

company. As a result, the CCAA is the reorganization regime of choice for complicated

reorganizations due to its flexibility.

a. Initiation of CCAA Proceedings

A CCAA reorganization is commenced by either the debtor or a creditor making an

application to the court for protection while a reorganization is developed (creditor

initiated reorganization are rare). The commencement of the proceeding is discretionary

on the part of the court, and the debtor is required to establish the existence of

circumstances that make an order under the CCAA appropriate. In general terms,

provided the debtor company can establish that it meets the requirements of the CCAA,

the burden will be upon opposing creditors to show why the court should not permit the

reorganization to proceed.

During a CCAA reorganization, the debtor usually continues to conduct its business

under its existing management. However, the CCAA requires that a monitor be appointed

to oversee the debtor’s reorganization and report back to the creditors and the court.

Monitors perform essentially the same function under the CCAA as trustees in BIA

reorganizations. However, the exact role that the monitor plays is ultimately determined

by the court.

For purposes of CCAA arrangements, the creditors are divided into classes and vote on

the plan presented by the debtor on a class-by-class basis. The majority required to

accept a plan is the same as under the BIA: two-thirds in value and a majority in number.

If the required majority is not achieved in a class, the plan is not binding on the creditors

of that class. Once accepted by the creditors, a plan must be approved by the court before

it becomes binding on the company’s creditors.



b. Stay of Proceedings

The CCAA provides for an initial stay of proceedings for a period up to thirty days, prior

to the expiry of which the debtor may request an extension. Usually the initial stay is

obtained by the debtor on an “ex-parte” basis, and the court will require service of the

supporting materials on all creditors prior to the first extension hearing which is usually

referred to as the “comeback” or “confirmation” hearing. When seeking any extension,

the burden is on the debtor to establish not only that the stay is appropriate, but that it has

acted and is acting in good faith and with due diligence. There are no statutory

restrictions on the period for which the stay can be extended.

As a result of the courts having interpreted the stay provisions of the CCAA broadly in

order to protect the integrity of the debtor’s business, the scope of the stay generally

granted by the court in CCAA reorganizations is quite broad.

c. Doing Business with the Reorganizing Debtor

It is common for a CCAA order to include extensive stay provisions that prevent

suppliers from terminating or amending agreements with the reorganizing debtor on any

basis whatsoever. These provisions are typically much more extensive than the

comparable sections of the BIA. However, section 11.3 of the CCAA parallels

subsection 65.1(4) of the BIA and provides that “no stay of proceedings granted under

the CCAA can have the effect of prohibiting a person from requiring immediate payment

for goods, services or the use of leased or licensed property, or requiring the further

advance of money or credit”38.

The CCAA, like the BIA, is silent as to the treatment of suppliers who supplied goods

and services to a reorganizing debtor and generally these creditors will be ordinary

unsecured creditors. The CCAA, unlike the BIA, does not provide for a deemed

bankruptcy in the event that a attempt reorganization is unsuccessful. Nonetheless, as a

practical matter, the failure of a CCAA reorganization will, more often than not, result in

a liquidation of the debtor. 38 CCAA s. 11.3.



In addition to the negotiated compromises found in BIA reorganizations to protect

suppliers, the exercise of inherent jurisdiction by the court and the flexibility of the

CCAA process make it possible for the court to create structures that limit a suppliers’

risk exposure during a CCAA reorganization. For example, in the CCAA reorganization

of Smoky River Coal Ltd., the Alberta Court of Queens’ Bench made an order which

created a charge, limited to $7 million, over the debtor’s property to secure amounts

owing to “Post-Petition Trade Creditors”39. The charge was created to encourage the

debtor’s regular trade creditors to continue to provide essential goods and services during

the company’s reorganization. The order made in Smoky River Coal was similar to the

Order made by the British Columbia Supreme Court in the 1992 reorganization of Westar

Mining Ltd. In Re Westar Mining the court made an order granting suppliers a priority

charge to secure credit supplied during the restructuring.40 Specifically, the judge stated

that “the essential problem here is how to enable the company to continue operating until

September 30, 1992. … I accept the argument that the most equitable compromise is to

make security over [the debtor’s assets], with the highest possible priority, available to

those who will finance the company’s continuing operations.”

At the conclusion of a successful CCAA reorganization, the “sanction” order of the court

approving the restructuring plan typically contains a provision which compels the parties

to all executory contracts to honour such contracts in accordance with their terms on the

basis that all insolvency or financial defaults existing at the date of the proceedings or

created as a result of the proceedings are deemed to have been cured by the restructuring

process. The contracting party is thereby prevented from terminating a contract after the

stay of proceedings terminates. The contracting party is instead limited to an unsecured

claim under the restructuring plan for any damages resulting from such defaults.

39 See Re Smoky River Coal Ltd. (2000), 19 C.B.R. (4th ) 281 (Alts. Q.B.). 40 See Re Westar Mining Ltd. (1992), 70 B.C.L.R. (2d) 6 (S.C.) and Re Companies’ Creditors

Arrangement Act (1993), 30 C.B.R. (3d) 119 (B.C.S.C.).



d. Termination of Contracts

Although not specifically provided for in the legislation, it is standard practice for CCAA

orders to permit the reorganizing company to terminate or disclaim contracts during the

course of the restructuring. These orders generally provide for any damages resulting

from any termination of a contract by the debtor to be an unsecured claim in the

reorganization. For example, in Re Blue Range Resources Corp.,41 the Court found that

an order authorizing the terminations of contracts was appropriate in a restructuring.

Similarly, the Ontario Superior Court of Justice has stated that “[i]t is clear that under

CCAA proceedings debtor companies are permitted to unilaterally terminate in the sense

of repudiate leases and contracts without regard to the terms of those leases and contracts

…” 42 In commenting on the situation facing parties to contracts terminated by a

reorganizing debtor, the court in Re Blue Range observed, quite correctly, that the other

parties to terminated contracts “will be relegated to the ranks of unsecured judgment

creditors and may not, indeed likely will not, have their judgments satisfied in full.”

It appears that the threshold question in an attempt to disclaim or terminate a contract in a

CCAA may be whether that contract had the effect of transferring an interest in property.

In Re T Eaton Company Limited 43 the court implied that a debtor could not disclaim a

contract that vested property rights in the other party to the contract.

e. Assignment of Contracts

The law with respect to the assignment of commercial contracts which has developed

outside of insolvency has been applied in CCAA reorganizations.

In Re American Eco Corporation44 the court applied the reasoning in Welch Foods in the

CCAA context where the court was asked to force the assignment of a joint venture

contract. It appears that the contract party was asking for some form of bonus as a

41 (1999), 245 A.R. 154 (Alta. Q.B.). 42 Re T. Eaton Company Limited (1999), 14 C.B.R. (4th) 288 (Ont. Sup. Ct.). 43 See argument in Re T. Eaton Company Limited (1999), 14 C.B.R. (4th) 288 (Ont. Sup. Ct.). 44 (October 24, 2000), Court File No. 00-CL-3841 (Ont. Gen. Div.).



condition to providing its consent to the assignment. The court found that there was no

“financial or operational reason” for the refusal to consent to the assignment and that “in

the circumstances prevailing of the insolvency that [the contract party] is attempting to

confiscate value which should otherwise be attributable to the creditors” and permitted

the assignment without consent.

In Re Playdium Entertainment Corp.,45 the court also considered the assignment of a

contract in the context of a CCAA reorganization. After an unsuccessful attempt by

Playdium to restructure, a plan to save the company’s business was put forward by the

company’s secured creditors. The plan provided for substantially all of Playdium’s assets

including its materials contracts, to be transferred to a new corporation called Newco,

controlled by the secured creditors. Newco would then continue to operate the business

as a going concern. The plan was to be implemented by appointing an interim receiver

over Playdium’s assets to effect the transfer.

Among the contracts to be transferred to Newco was a contract with Famous Players Inc.

Famous Players refused, however, to consent to the assignment of this contract to Newco

because Playdium was in default under the contract, a proper request for consent to the

assignment of the contract to Newco had not been made, and adequate financial

information and assurances as to the management of Newco and information respecting

how the agreement was to be brought into good standing had not been provided. A

motion was brought by the secured creditors seeking an order implementing the plan and

compelling the assignment of the Famous Players agreement to Newco. This motion

contemplated that from the assignment date, Newco would become bound to perform

Playdium’s obligations under the contract and would be entitled to require Famous

Players to perform its obligations, and Famous Players would be entitled to exercise

contractual termination rights based on defaults arising or continuing after the assignment

date.

45 [2001] O.J. No. 4252 (Sup. Ct.) with additional reasons at [2001] O.J. No. 4459 (Sup. Ct.). See also

“Secured Creditors Lead Playdium CCAA Restructuring” Lexpert (March, 2002) 57.



In considering whether to compel the assignment of the contract to Newco, the court

addressed both its jurisdictional powers to make an order compelling the assignment of

the contract to Newco and whether it was appropriate, in the circumstance, to make such

an order46.

After analysing the case law concerning the application of the provisions of the CCAA

that permit the court to stay proceedings and to exercise inherent jurisdiction under the

CCAA, the court found that having regard to the purpose of the CCAA (to facilitate a

reorganization to allow the business to continue) and the necessary inference that the stay

provisions were to be used to advance that purpose, the jurisdiction existed to make an

order compelling the assignment.

Prior to deciding whether it was appropriate to compel the assignment of the agreement

to Newco, the court found that Famous Players was refusing to consent to the assignment

to Newco because of Playdium’s continuing defaults under the agreement and because of

the prospect of a better deal with another party. The court found that, although it would

be reasonable for Famous Players to refuse its consent to the assignment of the contract

to Newco outside of the CCAA context, in the context of a CCAA restructuring it was

appropriate to compel the assignment of the contract.

It remains to be seen whether the court will apply the reasoning in American Eco and

Playdium to insolvency situations other than CCAA reorganizations. It also remains to

be seen whether the courts will expand the circumstances in which it will compel the

assignment of contracts to situations where the contract, by its terms, is not assignable or

where consent to assignment can be arbitrarily withheld.

V. Court-Appointed Receivers

In the insolvency context, receivership is generally regarded as a secured creditor’s

remedy. A receiver can be appointed to take possession of a debtor’s assets either by a

secured creditor pursuant to powers granted in a security agreement or by the court

46 The analysis with respect to jurisdiction appears in the supplementary reasons issued after an additional

hearing.



Because both receivership and bankruptcy may arise in the context of an insolvency,

there is often some confusion between the two concepts. The confusion between

bankruptcy and receivership is further complicated by the fact that it is possible for a

trustee in bankruptcy to be appointed receiver by a secured creditor with security over the

bankrupt’s assets47. It is important to recognize however, that receivership, as a remedy,

is not synonymous with bankruptcy and that the two are separate and distinct remedies

notwithstanding that they can, and often do, occur contemporaneously.

A court-appointed receiver is an officer of the court and the scope and extent of its

powers will be determined by the order pursuant to which it is appointed. It is common

for orders appointing receivers to include provisions staying proceedings against the

debtor’s property, hence permitting the receiver to operate the debtor’s business and

restricting the ability of parties to contract with the debtor from terminating or amending

those contracts. Receivership orders will also typically include provisions that allow the

receiver to market and sell the debtor’s assets either as a going concern or piecemeal.

Generally speaking, a court-appointed receiver is not bound by the debtor’s contracts and,

subject to the provisions in the receivership order pursuant to which it was appointed,

may disclaim contracts. However, a decision of the Alberta Court of Queens Bench calls

into question whether a court-appointed receiver could disclaim contracts without regard

for the impact of that disclaimer on the other party to the contract.

In Bank of Montreal v. Probe Exploration Inc.48, the court was called upon to consider

whether it was appropriate for a court-appointed receiver to terminate contracts where the

effect of the termination would increase the realizable value of the company’s assets, but

would cause serious damage to the other party to the contract. The court found that a

court-appointed receiver owes an obligation to all stakeholders and would not permit the

terminations. On appeal, the Alberta Court of Appeal upheld the lower court’s

decision49. It is not clear, however, to what extent this decision will be followed in the

47 BIA s. 13.4. 48 (May 15, 2000) Court File No. 0001-02917 (Alta. Q.B.) 49 2000 Carswell Alta 1621 (Alta. C.A.).



receivership context or whether the reasoning in the case will be considered in the CCAA

context.

It may also be the case that parties to contracts with an insolvent debtor in receivership

can seek to have the receiver bound by these contracts. In Coopérants, Société mutuelle

d’assurance-vie c. Raymond, Chabot, Faford, Gagnon Inc.50, the Supreme Court of

Canada found that a liquidator under the Winding-up and Restructuring Act51 – what they

analogized to a receiver appointed by the court – was in a different position than a

bankruptcy trustee and would be bound by an agreement that provided for specific

obligations arising in the event of insolvency. It should be noted, however, that the court

did not have any evidence with respect to the value of the assets in question. Moreover,

it is unclear if this case would be followed where the court has ordered that a receiver

may disclaim contracts.

VI. Interim Receivers

The interim receiver is a creation of the BIA. The BIA provides for the optional

appointment of a bankruptcy trustee as an “interim receiver” to preserve the property of

an insolvent debtor pending the hearing of a Petition52, or to preserve the interests of a

secured creditor pending the enforcement of security53, or to preserve a reorganizing

debtor’s property or the interests of creditors generally in a reorganization54. The court

has a broad jurisdiction under the BIA in that context to direct an interim receiver to take

possession and exercise control over the debtor’s property and business, and “take such

other actions as the court considers advisable.”55

50 (1996) 39 C.B.R. (3d) 253 (S.C.C.). 51 R.S.C. 1985 c. W-11, as amended. 52 BIA s. 46. 53 BIA s. 47. Section 244 of the BIA requires that a secured creditor enforcing security over all or

substantially of an insolvent debtor’s inventory, receivables or other property provide that debtor with ten day’s notice.

54 BIA s. 47.1. 55 BIA s. 47(2)(c) and s. 47.1(2)(d).



In recent years, the interim receiver role has evolved to that point that it now serves a

function that goes far beyond the preservation of the insolvent debtor’s assets. The

concept has also been used in the context of some CCAA proceedings, particularly where

an asset liquidation is the result of the restructuring attempt. One of the more common

applications of an interim receiver is to facilitate the sale of assets located in more than

one jurisdiction or to “avoid” some of the adverse consequences of a court-appointed

receiver, such as the application of the rights of unpaid suppliers to recover goods

shipped to the insolvent debtor56. As mentioned above, the secured creditors in Playdium

accomplished the transfer of the company’s assets through the appointment of an interim

receiver.

In practice, it is not unusual to see interim receivership orders that include comprehensive

stays of proceedings and provisions restricting the termination of contracts. In this

respect, they often resemble orders made under the CCAA or in conventional

receivership proceedings.

VII. Insolvency Reform

The federal government is currently engaged in a process to review Canada’s insolvency

legislation, with the intention of presenting amendments to both the BIA and the CCAA

to Parliament for its consideration later this year.

Although it is impossible to predict what specific amendments, if any, might arise from

this latest insolvency review process, a joint proposal from the Insolvency Institute of

Canada and the Canadian Institute of Insolvency and Restructuring Professionals has

recommended several amendments which, if accepted, might assist in bringing more

clarity to some of the issues facing parties affected by the insolvency of a corporation

carrying on business in a knowledge based industry. For example, the proposed

amendments include a much more detailed regime for the adoption or disclaimer of

executory contracts and protection of rights for the holders of property interests.

However, none of these proposed reforms appear to be directed towards the unique issues 56 An interim receiver does not fall within the definition of “receiver” in the BIA and, as a result, does not

trigger the rights provided to unpaid suppliers under section 81.1 of the BIA.




associated with information technology. This is both surprising and disappointing

considering the number of insolvencies occurring in the information technology industry

in recent years and the economic consequences to industry participants from a continuing

climate of uncertainty.

Some insolvency practitioners have suggested that an economic disadvantage arises for

Canadian entities as a result of the uncertainties which exist in the Canadian insolvency

context in relation to information technology issues, given that many of the corporations

in this industry will have contractual dealings with corporations based in the United

States. Such U.S. corporations, who are familiar with the far more extensively legislated

rights available to them under U.S. bankruptcy law, and in particular Chapter 11 (the

U.S. equivalent to the CCAA), are typically astounded to hear of the risks of entering into

the Canadian marketplace and placing their information technology within the potential

embrace of a Canadian trustee or receiver. It is not too late for the information

technology industry to lobby the federal government for specific amendments to

insolvency legislation which more properly recognize the growth of technology based

business and the unique problems arising for them in the insolvency context.

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